Gangster-Free Capitalism?

Oleg Deripaska survived Russia's bloody privatization. Now, just like the country as a whole, he is practicing a more civilized form of business.

To hear Russian tycoon
Oleg Deripaska
Oleg
Deripaska
tell it, the main problem facing Russia today is bad public relations. Deripaska, 33, is founder and one of the controlling shareholders of
Russian Aluminum
, the world's second-largest aluminum producer, but he says he gets no respect.

Case in point: Three years ago Deripaska met with U.S. Treasury Secretary Paul O'Neill at a Rand Corp. conference. O'Neill was chairman of Alcoa at the time, and Deripaska tried to get him to invest in Russia's aluminum smelters.

"O'Neill had an emotional reaction that the level of corruption was too high to do serious projects in Russia,' Deripaska recalls. "He told me: 'I don't want to pay bribes every time my product has to cross a bridge.' I told him that I didn't have to pay bribes, but I couldn't convince him.'

Would Alcoa have a different response today? It might. Now, with Russia and the U.S. making common cause in the war against terrorism, a lot of shelved investment projects may get a second look. "It is no more difficult to work in Russia than in China,' claims Deripaska. "We simply have an image problem.'

Perhaps that is an understatement. Last December several of his business rivals filed a lawsuit in the U.S. District Court in Manhattan alleging that Deripaska and his partners used death threats, gangsters and fraud to gain control of an aluminum smelter in the Siberian town of Novokuznetsk. Assuming the plaintiffs can overcome any objections to this choice of forum for a Russian dispute, they will try to maintain the action under the expansive Racketeer Influenced & Corrupt Organizations (RICO) statute, which permits a trebling of damages.

Western producers

Russian producers

Average 2000 cash price per metric ton of primary aluminum

$1,549

$1,549

COSTS

Alumina and other material inputs

740

869

Electricity

274

156

Labor

157

49

Other

66

90

Total

1,237

1,164

Operating profit per metric ton

$312

$385

Sources: CRU International, Ltd.; Troika Dialog.

Deripaska's longtime partner,
Mikhail Chernoi
Mikhail
Chernoi
, has been detained twice by police--once in Switzerland and more recently in Israel--and questioned about possible links to organized crime. Deripaska himself was disinvited from the Davos conference this year; he has also been denied entry into the U.S.

One of the initiators of the RICO suit, a fugitive Russian businessman named Mikhail Zhivilo, has his own image problems. In Russia there is an outstanding warrant for his arrest on the charge of plotting the murder of a Siberian governor.

Deripaska brushes aside the RICO allegations simply as an attempt by the disgruntled Zhivilo to get more money on top of the $100 million he was paid for the Novokuznetsk smelter.

Whether he is innocent or not, Deripaska's problem is that he has made his career in one of the most criminalized sectors of the Russian economy. In the early 1990s, as communism fell, unscrupulous traders rushed to grab control of Russia's industrial assets. The giant aluminum industry, one of Russia's top export earners (about $4 billion a year), was a juicy prize.

Initially the dominant player in this game was Marc Rich, the fugitive U.S. commodities trader famously pardoned by President Clinton. By 1993 the companies most directly associated with Rich began to be pushed out and a new player emerged to dominate the Russian aluminum business: a loose association of commodities traders commonly known as the Trans-World group. The group was led by two Russian brothers, Mikhail Chernoi and his brother, Lev, and two traders based in Western Europe, David and Simon Reuben. Operating out of London, Geneva, Monte Carlo and Moscow, Trans-World bought controlling stakes in most of Russia's biggest smelters and locked up most of the big export contracts.

Deripaska, meanwhile, was a small-time metals trader who had started in business while still a student at Moscow State University. Between 1993 and 1994 he accumulated a 20% stake in the 285,000-ton-a-year Sayansk aluminum smelter. Such were the prices in the privatization fire sale that the stake cost Deripaska just a few million dollars. The other big shareholder in Sayansk was Trans-World. Deripaska joined forces with Trans-World to take over Sayansk.

"The plant was grinding to a halt,' Deripaska recalls. "We kicked out the old director. I wanted to put in someone else, but I found out that [my replacement candidate] was linked to a local gangster organization, so I had to take over the plant myself. That's when I started having problems.'

Problems? That's Deripaska's delicate way of referring to the four years of violence that swept across the aluminum sector. When the smoke had cleared, dozens of executives, bankers, traders and mob bosses were dead. The bloodiest battles were fought over the gigantic Krasnoyarsk aluminum smelter. For several years this enterprise was up for grabs. Trans-World had a 20% stake, but rival trading companies also had a claim on the business, as did the local gangster organization.

In the summer of 1995 Oleg Kantor, the president of a bank that had recently taken an important position in Krasnoyarsk, was ambushed in his car in Moscow, shot and stabbed to death.

A month later it was the turn of Felix Lvov of AIOC, the New York-based trading company that had the Krasnoyarsk export contract. Lvov, the point man for AIOC in Russia, was accosted and led away by two men in uniform as he was preparing to board a plane at a Moscow airport. His corpse was found in a forest several days later; AIOC withdrew from Krasnoyarsk and declared bankruptcy.

In the late 1990s, with most of its rivals having fallen by the wayside, Trans-World took control of the Krasnoyarsk aluminum smelter in cooperation with one Anatoli Bykov. Bykov is a former boxer who became the plant's manager; he is now in a Moscow jail awaiting trial on a murder charge.

By this time the original Trans-World group had split up. The older of the Chernoi brothers, Mikhail, quarreled with the others, cashed out and joined Deripaska at the Sayansk smelter.

Deripaska says that he steered clear of the gang wars and stayed focused on the pot lines. By 2000 he had boosted production to 450,000 tons. But he really proved himself a different kind of aluminum industrialist in 1999, when he began lobbying against the practice that had made traders like Trans-World fabulously wealthy: tolling--a type of barter by which a trader lends the aluminum smelter raw materials and gets finished aluminum back. Through tolling contracts, traders were able to transfer profits offshore--by inflating the price of the ore and/or deflating the price of exported aluminum--and thereby skirt Russian taxes.

How big were these profits? Earlier this year the German government began investigating the origins of nearly $1 billion that companies associated with Trans-World had deposited in German banks. (The investigation was recently dropped for lack of evidence of any crime.)

"The tolling system was really a giant pump, sucking the cash out of the factories and parking it abroad,' Deripaska says. "But we needed investments at home.'

Deripaska began to lobby against tolling with TV advertisements, billboards and personal appeals to lawmakers--and succeeded. A lot of the tax loopholes that made tolling so lucrative have been closed. There may have been more than altruism behind Deripaska's actions, since the antitolling campaign helped loosen Trans-World's stranglehold on the Russian aluminum industry. Early last year Trans-World sold most of its aluminum holdings to billionaire oil magnate Roman Abramovich, who merged them with Deripaska's company to create Russian Aluminum.

The new company, managed by Deripaska, has $4.5 billion in sales, and accounts for 70% of Russia's aluminum production. It remains a jumble of interlocking shareholdings and murky personal relationships, but Deripaska says he intends to refashion it as a transparent Western-style corporation. Someday. In the meantime Deripaska lets go of only a few financials: He has invested $120 million in Russia's first big aluminum can factory and several hundred million more into modernizing smelters, purchasing alumina refineries and leasing a bauxite mine in Africa.

Such are the profits rolling out of the smelters that Deripaska has had the extra cash to buy big stakes in automobile manufacturers, aerospace companies and coal mines in Russia. "If I were to invest in the West, I would make a return of 10% on average,' Deripaska says. "In Russia we have had successes and failures, but our average return is 35%.' This kind of thinking has endeared Deripaska to Vladimir Putin, who is anxious to stop the looting of his country.

The new Russian president seems to have struck an informal deal with his country's industrialists: I won't investigate past criminal behavior if you stay out of politics and reinvest your profits in Russia. (Deripaska, of course, denies any past criminal behavior.)

In the wake of Sept. 11, Russia and the West are drawing closer, and cross-border investments will become common. But even if Deripaska acts like a perfect corporate citizen and a superb industrial manager, it will probably take years to dissipate the stench of criminality surrounding the industry he now controls.